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Behavioural Finance Martin Sewell University of Cambridge February 2007 (revised April 2010) Abstract An introduction to behavioural

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Behavioural Finance Martin Sewell University of Cambridge February 2007 (revised April 2010) Abstract An introduction to behavioural

nance, including a review of the major works and a summary of important heuristics. 1 Introduction Behavioural

nance is the study of the in uence of psychology on the behaviour of

nancial practitioners and the subsequent e ect on markets. Behavioural

nance is of interest because it helps explain why and how markets might be ine

cient. For more information on behavioural

nance, see Sewell (2001). 2 History Back in 1896, Gustave le Bon wrote The Crowd: A Study of the Popular Mind, one of the greatest and most in uential books of social psychology ever written (le Bon 1896). Selden (1912) wrote Psychology of the Stock Market. He based the book `upon the belief that the movements of prices on the exchanges are dependent to a very considerable degree on the mental attitude of the investing and trading public'. In 1956 the US psychologist Leon Festinger introduced a new concept in social psychology: the theory of cognitive dissonance (Festinger, Riecken and Schachter 1956). When two simultaneously held cognitions are inconsistent, this will produce a state of cognitive dissonance. Because the experience of dissonance is unpleasant, the person will strive to reduce it by changing their beliefs. Pratt (1964) considers utility functions, risk aversion and also risks considered as a proportion of total assets. Tversky and Kahneman (1973) introduced the availability heuristic: `a judgmental heuristic in which a person evaluates the frequency of classes or the probability of events by availability, i.e. by the ease with which relevant instances come to mind.' The reliance on the availability heuristic leads to systematic biases. 1In 1974, two brilliant psychologists, Amos Tversky and Daniel Kahneman, described three heuristics that are employed when making judgments under uncertainty (Tversky and Kahneman 1974): representativeness When people are asked to judge the probability that an object or event A belongs to class or process B, probabilities are evaluated

by the degree to which A is representative of B, that is, by the degree to which A resembles B. availability When people are asked to assess the frequency of a class or the probability of an event, they do so by the ease with which instances or occurrences can be brought to mind. anchoring and adjustment In numerical prediction, when a relevant value (an anchor) is available, people make estimates by starting from an initial value (the anchor) that is adjusted to yield the

nal answer. The anchor may be suggested by the formulation of the problem, or it may be the result of a partial computation. In either case, adjustments are typically insu

cient. The most cited paper ever to appear in Econometrica, the prestigious academic journal of economics, was written by the two psychologists Kahneman and Tversky (1979). They present a critique of expected utility theory (Bernoulli 1738; von Neumann and Morgenstern 1944; Bernoulli 1954) as a descriptive model of decision making under risk and develop an alternative model, which they call prospect theory. Kahneman and Tversky found empirically that people underweight outcomes that are merely probable in comparison with outcomes that are obtained with certainty; also that people generally discard components that are shared by all prospects under consideration. Under prospect theory, value is assigned to gains and losses rather than to

nal assets; also probabilities are replaced by decision weights. The value function is de

ned on deviations from a reference point and is normally concave for gains (implying risk aversion), commonly convex for losses (risk seeking) and is generally steeper for losses than for gains (loss aversion) (see Figure 1 (page 3)). Decision weights are generally lower than the corresponding probabilities, except in the range of low probabilities. The theory|which they con

rmed by experiment|predicts a distinctive fourfold pattern of risk attitudes: risk aversion for gains of moderate to high probability and losses of low probability, and risk seeking for gains of low probability and losses of moderate to high probability. Thaler (1980) argues that there are circumstances when consumers act in a manner that is inconsistent with economic theory and he proposes that Kanneman and Tversky's prospect theory be used as the basis for an alternative descriptive theory. Topics discussed are: underweighting of opportunity costs, failure to ignore sunk costs, search behaviour, choosing not to choose and regret, and precommitment and self-control. The paper introduced the notion of `mental accounting' (described below). In another important paper Tversky and Kahneman (1981) introduced framing. They showed that the psychological principles that govern the perception 2Figure 1: A hypothetical value function in prospect theory of decision problems and the evaluation of probabilities and outcomes produce predictable shifts of preference when the same problem is framed in di erent ways. Shiller (1981) discovered that stock price volatility is far too high to be attributed to new information about future real dividends. Kahneman, Slovic and Tversky (1982) edit Judgment Under Uncertainty: Heuristics and Biases, thirty-

ve chapters which describe various judgmental heuristics and the biases they produce. In 1985 Werner F. M. De Bondt and Richard Thaler published `Does the stock market overreact?' in the The Journal of Finance (De Bondt and Thaler 1985), e ectively forming the start of what has become known as behavioural

nance. They discovered that people systematically overreacting to unexpected and dramatic news events results in substantial weak-form ine

ciencies in the stock market. This was both surprising and profound. Mental accounting is the set of cognitive operations used by individuals and households to organize, evaluate and keep track of

nancial activities. Thaler (1985) developed a new model of consumer behaviour involving mental accounting. Tversky and Kahneman (1986) argue that, due to framing and prospect theory, the rational theory of choice does not provide an adequate foundation for a descriptive theory of decision making. Yaari (1987) proposes a modi

cation to expected utility theory and obtains a so-called `dual theory' of choice under risk. De Bondt and Thaler (1987) report additional evidence that supports the overreaction hypothesis. Samuelson and Zeckhauser (1988) perform a series of decision-making experiments and

nd evidence of status quo bias. Poterba and Summers (1988) investigate transitory components in stock prices and found positive autocorre3lation in returns over short horizons and negative autocorrelation over longer horizons, although random-walk price behaviour cannot be rejected at conventional statistical levels. Kahneman, Knetsch and Thaler (1990) report several experiments that demonstrate that loss aversion and the endowment e ect persist even in market settings with opportunities to learn and conclude that they are fundamental characteristics of preferences. Gilovich (1991) wrote How We Know What Isn't So, a book about the fallibility of human reason in everyday life. Tversky and Kahneman (1991) present a reference-dependent model of riskless choice, the central assumption of the theory being loss aversion, i.e. losses and disadvantages have greater impact on preferences than gains and advantages. Fernandez and Rodrik (1991) model an economy and show how uncertainty regarding the identities of gainers and losers can lead to status quo bias. Kahneman, Knetsch and Thaler (1991) discuss three anomalies: the endowment e ect, loss aversion and status quo bias. Thaler (1992) publishes The Winner's Curse: Paradoxes and Anomalies of Economic Life. Banerjee (1992) develop a simple model of herd behaviour. Tversky and Kahneman (1992) superseded their original implementation of prospect theory with cumulative prospect theory. The new methodology employs cumulative rather than separable decision weights, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows di erent weighting functions for gains and for losses (see Figure 2 below). I have develFigure 2: Typical probability weighting functions for gains (w +

) and losses (w

) in cumulative prospect theory oped a cumulative prospect theory calculator, which is freely available online

Behavioural FinanceBehavioural finance is the study of the influence of psychology on the behaviour of financial practitioners and the subsequent effect on markets. Sewell (2005) "I think of behavioral finance as simply "open-minded finance"." Thaler (1993) 'This area of enquiry is sometimes referred to as "behavioral finance," but we call it "behavioral economics." Behavioral economics combines the twin disciplines of psychology and economics to explain why and how people make seemimgly irrational or illogical decisions when they spend, invest, save, and borrow money.' Belsky and Gilovich (1999) "This paper examines the case for major changes in the behavioral assumptions underlying economic models, based on apparent anomalies in financial economics. Arguments for such changes based on claims of "excess volatility" in stock prices appear flawed for two main reasons: there are serious questions whether the phenomenon exists in the first place and, even if it did exist, whether radical change in behavioral assumptions is the best avenue for current research. The paper also examines other apparent anomalies and suggests conditions under which

such behavioral changes are more or less likely to be adopted." Kleidon (1986) "For most economists it is an article of faith that financial markets reach rational aggregate outcomes, despite the irrational behavior of some participants, since sophisticated players stande ready to capitalize on the mistakes of the naive. (This process, which we camm poaching, includes but is not limited to arbitrage.) Yet financial markets have been subject to speculative fads, from Dutch tulip mania to junk bonds, and to occasional dramatic losses in value, such as occurred in October 1987, that are hard to interpret as rational. Descriptive decision theory, especially psychology (see D. Kahneman et al., 1982), can help to explain such aberrant macrophenomena. Here we propose some behavioral explanations of overall market outcomesspecifically of financial flows, that are of considerable practical consequence to both policymakers and finance practitioners. Patel, Zeckhauser and Hendricks (1991) "Because psychology systematically explores human judgment, behavior, and well-being, it can teach us important facts about how humans differ from traditional economic assumptions. In this essay I discuss a selection of psychological findings relevant to economics. Standard economics assumes that each person has stable, well-defined preferences, and that she rationally maximizes those preferences. Section 2 considers what psychological research teaches us about the true form of preferences, allowing us to make economics more realistic within the rationalchoice framework. Section 3 reviews research on biases in judgment under uncertainty; because those biases lead people to make systematic errors in their attempts to maximize their preferences, this research poses a more radical challenge to the economics model. The array of psychological findings reviewed in Section 4 points to an even more radical critique of the economics model: Even if we are willing to modify our familiar assumptions about preferences, or allow that people make systematic errors in their attempts to maximize those preferences, it is sometimes misleading to conceptualize people as attempting to maximize well-defined, coherent, or stable preferences." Rabin (1996) "Market effciency survives the challenge from the literature on long-term return anomalies. Consistent with the market effciency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreaction, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market effciency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to disappear with reasonable changes in technique." Fama (1998)

"Recent literature in empirical finance is surveyed in its relation to underlying behavioral principles, principles which come primarily from psychology, sociology and anthropology. The behavioral principles discussed are: prospect theory, regret and cognitive dissonance, anchoring, mental compartments, overconfidence, over- and underreaction, representativeness heuristic, the disjunction effect, gambling behavior and speculation, perceived irrelevance of history, magical thinking, quasimagical thinking, attention anomalies, the availability heuristic, culture and social contagion, and global culture." Shiller (1998) "The field of modern financial economics assumes that people behave with extreme rationality, but they do not. Furthermore, peoples deviations from rationality are often systematic. Behavioral finance relaxes the traditional assumptions of financial economics by incorporating these observable, systematic, and very human departures from rationality into standard models of financial markets. We highlight two common mistakes investors make: excessive trading and the tendency to disproportionately hold on to losing investments while selling winners. We argue that these systematic biases have their origins in human psychology. The tendency for human beings to be overconfident causes the first bias in investors, and the human desire to avoid regret prompts the second." Barber and Odean (1999) "Behavioral Economics is the combination of psychology and economics that investigates what happens in markets in which some of the agents display human limitations and complications. We begin with a preliminary question about relevance. Does some combination of market forces, learning and evolution render these human qualities irrelevant? No. Because of limits of arbitrage less than perfect agents survive and influence market outcomes. We then discuss three important ways in which humans deviate from the standard economic model. Bounded rationality reflects the limited cognitive abilities that constrain human problem solving. Bounded willpower captures the fact that people sometimes make choices that are not in their long-run interest. Bounded self-interest incorporates the comforting fact that humans are often willing to sacrifice their own interests to help others. We then illustrate how these concepts can be applied in two settings: finance and savings. Financial markets have greater arbitrage opportunities than other markets, so behavioral factors might be thought to be less important here, but we show that even here the limits of arbitrage create anomalies that the psychology of decision making helps explain. Since saving for retirement requires both complex calculations and willpower, behavioral factors are essential elements of any complete descriptive theory." Mullainathan and Thaler (2000)

"Behavioral finance is a rapidly growing area that deals with the influence of psychology on the behavior of financial practitioners." Shefrin (2000) "Behavioral finance is the application of psychology to financial behavior the behavior of practitioners." Shefrin (2000) "Behavioral finance is the study of how psychology affects financial decision making and financial markets." Shefrin (2001) "Behavioral finance argues that some financial phenomena can plausibly be understood using models in which some agents are not fully rational. The field has two building blocks: limits to arbitrage, which argues that it can be diffcult for rational traders to undo the dislocations caused by less rational traders; and psychology, which catalogues the kinds of deviations from full rationality we might expect to see. We discuss these two topics, and then present a number of behavioral finance applications: to the aggregate stock market, to the cross-section of average returns, to individual trading behavior, and to corporate finance. We close by assessing progress in the field and speculating about its future course." Barberis and Thaler (2001) "This essay provides a perspective on the trend towards integrating psychology into economics. Some topics are discussed, and arguments are provided for why movement towards greater psychological realism in economics will improve mainstream economics." Rabin (2001) "The basic paradigm of asset pricing is in vibrant flux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both risk and misvaluation. This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models." Hirshleifer (2001) "Behavioral finance and behavioral economics are closely related fields which apply scientific research on human and social cognitive and emotional biases to better understand economic decisions and how they affect market prices, returns and the allocation of resources." Wikipedia (2005)

HistoryDuring the classical period, microeconomics was closely linked to psychology. For example, Adam Smith wrote The Theory of Moral Sentiments, which proposed psychological explanations of individual behavior and Jeremy Bentham wrote extensively on the psychological underpinnings of utility. However, during the development of neo-classical economics economists sought to reshape the discipline as a natural science, deducing economic behavior from assumptions about the nature of economic agents. They developed the concept of homo economicus, whose psychology was fundamentally rational. This led to unintended and unforeseen errors. However, many important neo-classical economists employed more sophisticated psychological explanations, including Francis Edgeworth, Vilfredo Pareto, Irving Fisher and John Maynard Keynes. Economic psychology emerged in the 20th century in the works of Gabriel Tarde, Katona[2] [1]

George

and Laszlo Garai.

[3]

Expected utility and discounted utility models began to gain acceptance,

generating testable hypotheses about decision making given uncertainty and intertemporal consumption respectively. Observed and repeatable anomalies eventually challenged those hypotheses, and further steps were taken by the Nobel prizewinner Maurice Allais, for example in setting out the Allais paradox, a decision problem he first presented in 1953 which contradicts the expected utility hypothesis.

Daniel Kahneman

In the 1960s cognitive psychology began to shed more light on the brain as an information processing device (in contrast to behaviorist models). Psychologists in this field, such as Ward Edwards,[4]

Amos

Tversky and Daniel Kahneman began to compare their cognitive models of decision-making under risk and uncertainty to economic models of rational behavior. In mathematical psychology, there is a longstanding interest in the transitivity of preference and what kind of measurement scale utility constitutes (Luce, 2000).[5]

[edit]Prospect

theory

In 1979, Kahneman and Tversky wrote Prospect theory: An Analysis of Decision Under Risk, an important paper that used cognitive psychology to explain various divergences of economic decision making from neo-classical theory.[6]

Prospect theory is an example of generalized expected

utility theory. Although not a conventional part of behavioral economics, generalized expected utility theory is similarly motivated by concerns about the descriptive inaccuracy ofexpected utility theory. In 1968 Nobel Laureate Gary Becker published Crime and Punishment: An Economic Approach, a seminal work that factored psychological elements into economic decision making. Becker, however, maintained strict consistency of preferences. Nobelist Herbert Simon developed the theory of Bounded Rationality to explain how people irrationally seek satisfaction, instead of maximizing utility, as conventional economics presumed. Maurice Allais produced "Allais Paradox", a crucial challenge to expected utility. Psychological traits such as overconfidence, projection bias, and the effects of limited attention are now part of the theory. Other developments include a conference at the University of Chicago,[7]

a

special behavioral economics edition of the Quarterly Journal of Economics ('In Memory of Amos Tversky') and Kahneman's 2002 Nobel for having "integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty".[8]

[edit]Intertemporal

choice

Behavioral economics has also been applied to intertemporal choice. Intertemporal choice behavior is largely inconsistent, as exemplified by George Ainslie's hyperbolic discounting (1975) which is one of the prominently studied observations, further developed by David Laibson, Ted O'Donoghue, and Matthew Rabin. Hyperbolic discounting describes the tendency to discount outcomes in near future more than for outcomes in the far future. This pattern of discounting is dynamically inconsistent (or time-inconsistent), and therefore inconsistent with basic models of rational choice, since the rate of discount between time t and t+1 will be low at time t-1, when t is the near future, but high at time t when t is the present and time t+1 the near future. The pattern can actually be explained through models of subadditive discounting which distinguishes the delay and interval of discounting: people are less patient (per-time-unit) over shorter intervals regardless of when they occur. Much of the recent work on intertemporal choice indicates that discounting is a constructed preference.[citation needed]

Discounting is influenced greatly by expectations,

framing, focus, thought listings, mood, sign, glucose levels, and the scales used to describe what is discounted. Some prominent researchers[who?]

question whether discounting, the major parameter of

intertemporal choice, actually describes what people do when they make choices with future consequences. Considering the variability of discount rates, this may be the case.

[edit]Other

areas of research

Other branches of behavioral economics enrich the model of the utility function without implying inconsistency in preferences. Ernst Fehr, Armin Falk, and Matthew Rabin studied "fairness", "inequity aversion", and "reciprocal altruism", weakening the neoclassical assumption of "perfect selfishness." This work is particularly applicable to wage setting. Work on "intrinsic motivation" by Gneezy and Rustichini and on "identity" by Akerlof and Kranton assumes agents derive utility from adopting personal and social norms in addition to conditional expected utility. "Conditional expected utility" is a form of reasoning where the individual has an illusion of control, and calculates the probabilities of external events and hence utility as a function of their own action, even when they have no causal ability to affect those external events.[9][10]

Behavioral economics caught on among the general public, with the success of books like Dan Ariely's Predictably Irrational. Practitioners of the discipline have studied quasi-public policy topics such as broadband mapping. [edit]Methodology Behavioral economics and finance theories developed almost exclusively from experimental observations and survey responses, although in more recent times real world data have taken a more prominent position. Functional magnetic resonance imaging (fMRI) allows determination of which brain areas are active during economic decision making. Experiments simulating markets such as stock trading and auctions can isolate the effect of a particular bias upon behavior. Such experiments can help narrow the range of plausible explanations. Good experiments are incentivecompatible, normally involving binding transactions and real money. [edit]Behavioral[11][12]

economics vs experimental economics

Note that behavioral economics is distinct from experimental economics, which uses experimental methods to study economic questions. Not all economics experiments are psychological. While many experimental economics studies probe psychological aspects of decision making, other experiments explore institutional features or serve as "beta testing" for new market mechanisms. Not all behavioral economics uses experiments, either; behavioral economists rely heavily on theory and on observational studies "in the field." [edit]Key

observations[13]

Three themes predominate in behavioral finance and economics:

Heuristics: People often make decisions based on approximate rules of thumb, not strict logic. See also cognitive biases and bounded rationality.

Framing: The collection of anecdotes and stereotypes that make up the mental emotional filters individuals rely on to understand and respond to events.

Market inefficiencies: These include mis-pricings, non-rational decision making, and return anomalies. Richard Thaler, in particular, has described specific market anomalies from a behavioral perspective.

Barberis, Shleifer, and Vishny

[14]

and Daniel, Hirshleifer, and Subrahmanyam (1998)

[15]

built models

based on extrapolation (seeing patterns in random sequences) and overconfidence to explain security market under- and overreactions, though their source continues to be debated. These models assume that errors or biases are positively correlated across agents so that they do not cancel out in aggregate. This would be the case if a large fraction of agents look at the same signal (such as the advice of an analyst) or have a common bias. More generally, cognitive biases may also have strong anomalous effects in the aggregate if there is social contagion of ideas and emotions (causing collective euphoria or fear) leading to phenomena such as herding and groupthink. Behavioral finance and economics rests as much on social psychology within large groups as on individual psychology. In some behavioral models, a small deviant group can have substantial market-wide effects (e.g. Fehr and Schmidt, 1999). [edit]Topics Models in behavioral economics typically address a particular market anomaly and modify standard neo-classical models by describing decision makers as using heuristics and subject to framing effects. In general, economics continues to sit within the neoclassical framework, though the standard assumption of rational behavior is often challenged. [edit]Heuristics Prospect theory Loss aversion Disappointment Status quo bias Gambler's fallacy Self-serving bias Money illusion[citation needed]

[edit]Framing Cognitive framing Mental accounting Anchoring

[edit]Anomalies

(economic behavior)

Disposition effect Endowment effect

Inequity aversion Reciprocity Intertemporal consumption Present-biased preferences Momentum investing Greed and fear Herd behavior Sunk-cost fallacy

[edit]Anomalies

(market prices and returns)

Equity premium puzzle Efficiency wage hypothesis Price stickiness Limits to arbitrage Dividend puzzle Fat tails Calendar effect[15]

[edit]Criticisms Critics of behavioral economics typically stress the rationality of economic agents.[16]

They contend

that experimentally observed behavior has limited application to market situations, as learning opportunities and competition ensure at least a close approximation of rational behavior. Others note that cognitive theories, such as prospect theory, are models of decision making, not generalized economic behavior, and are only applicable to the sort of once-off decision problems presented to experiment participants or survey respondents.[citation needed]

Traditional economists are also skeptical of the experimental and survey-based techniques which behavioral economics uses extensively. Economists typically stress revealed preferencesover stated preferences (from surveys) in the determination of economic value. Experiments and surveys are at risk of systemic biases, strategic behavior and lack of incentive compatibility. Rabin (1998)[17] [citation needed]

dismisses these criticisms, claiming that consistent results are typically obtained in

multiple situations and geographies and can produce good theoretical insight. Behavioral economists have also responded to these criticisms by focusing on field studies rather than lab experiments. Some economists see a fundamental schism betweenexperimental economics and behavioral economics, but prominent behavioral and experimental economists tend to share techniques and approaches in answering common questions. For example, behavioral economists are actively investigating neuroeconomics, which is entirely experimental and cannot be verified in the field.needed] [citation

Other proponents of behavioral economics note that neoclassical models often fail to predict outcomes in real world contexts. Behavioral insights can influence neoclassical models. Behavioral economists note that these revised models not only reach the same correct predictions as the traditional models, but also correctly predict some outcomes where the traditional models failed.[verification needed]

[edit]Behavioral [edit]Topics

finance

The central issue in behavioral finance is explaining why market participants make systematic errors. Such errors affect prices and returns, creating market inefficiencies. It also investigates how other participants arbitrage such market inefficiencies. Behavioral finance highlights inefficiencies such as under- or over-reactions to information as causes of market trends (and in extreme cases of bubbles and crashes). Such reactions have been attributed to limited investor attention, overconfidence, overoptimism, mimicry (herding instinct) and noise trading. Technical analysts consider behavioral economics' academic cousin, behavioral finance, to be the theoretical basis for technical analysis.[18]

Other key observations include the asymmetry between decisions to acquire or keep resources, known as the "bird in the bush" paradox, and loss aversion, the unwillingness to let go of a valued possession. Loss aversion appears to manifest itself in investor behavior as a reluctance to sell shares or other equity, if doing so would result in a nominal loss.[19]

It may also help explain why

housing prices rarely/slowly decline to market clearing levels during periods of low demand. Benartzi and Thaler (1995), applying a version of prospect theory, claim to have solved the equity premium puzzle, something conventional finance models have been unable to do so far.[20]

Experimental finance applies the experimental method, e.g. creating an artificial market by some

kind of simulation software to study people's decision-making process and behavior in financial markets. [edit]Models Some financial models used in money management and asset valuation incorporate behavioral finance parameters, for example: Thaler's model of price reactions to information, with two phases, underreaction-adjustmentoverreaction, creating a price trend One characteristic of overreaction is that average returns following announcements of good news is lower than following bad news. In other words, overreaction occurs if the market reacts too strongly or for too long to news, thus requiring adjustment in the opposite direction. As a result, outperforming assets in one period are likely to underperform in the following period.

The stock image coefficient

[edit]Criticisms Critics such as Eugene Fama typically support the efficient-market hypothesis. They contend that behavioral finance is more a collection of anomalies than a true branch of finance and that these anomalies are either quickly priced out of the market or explained by appealing to market microstructure arguments. However, individual cognitive biases are distinct from social biases; the former can be averaged out by the market, while the other can create positive feedback loops that drive the market further and further from a "fair price" equilibrium. Similarly, for an anomaly to violate market efficiency, an investor must be able to trade against it and earn abnormal profits; this is not the case for many anomalies.[21]

A specific example of this criticism appears in some explanations of the equity premium puzzle. It is argued that the cause is entry barriers (both practical and psychological) and that returns between stocks and bonds should equalize as electronic resources open up the stock market to more traders.[22]

In reply, others contend that most personal investment funds are managed

through superannuation funds, minimizing the effect of these putative entry barriers. In addition, professional investors and fund managers seem to hold more bonds than one would expect given return differentials. [edit]Quantitative Quantitative behavioral finance uses mathematical and statistical methodology to understand behavioral biases. Leading contributors include Gunduz Caginalp (Editor of the Journal of Behavioral Finance from 20012004) and collaborators including 2002 Nobelist Vernon Smith, David Porter, Don Balenovich,[23] [24] [25]

Vladimira Ilieva and Ahmet Duran

and Ray Sturm.

The research can be grouped into the following areas: 1. Empirical studies that demonstrate significant deviations from classical theories 2. Modeling using the concepts of behavioral effects together with the non-classical assumption of the finiteness of assets 3. Forecasting based on these methods 4. Testing models against experimental asset markets